Bush shows how not to repair a broken economy

Robert Kuttner

October 18, 1991|By Robert Kuttner

PRESIDENT Bush's move to loosen bank capital requirements is bad policy and a sign of escalating political panic. The Republican panic is understandable; the usual measures to stimulate a recovery are not working and a double-dip recession could make the 1992 election a real horse race.

Normally, the government has two anti-recession medicines: bigger deficits or looser money. But this time deficit spending is out of the question, since the federal deficit is already enormous. On the monetary front, the administration has been leaning on the Federal Reserve to open the money spigot.

The Federal Reserve has sought to comply, and interest rates are now at their lowest level in 15 years. But with personal income stagnant, bankruptcies at record levels, unemployment stubbornly high, property values declining and consumers reluctant to buy, entrepreneurs are not rushing to borrow money produce goods that cannot be sold.

Administration officials have blamed the Fed for not loosening money aggressively enough. They fault bank regulators for overreacting to the excesses of the 1980s. And they blame chastened bankers for refusing to lend even to creditworthy borrowers.

But the administration is wrong on all counts. While there are indeed some traumatized bankers, a credit crunch is not the main problem nor are looser capital standards for banks any solution.

Banks and bank regulators are right to demand creditworthy borrowers. The problem is a genuine shortage of such borrowers. What President Bush calls a credit crunch is really the due bill for the wrongheaded policies of the Reagan-Bush era.

The experiment in supply-side economics and deregulation, let's recall, was supposed to stimulate savings, investment and entrepreneurship. The tax cuts would offer investors higher after-tax returns. That would induce people to save and invest more. The ensuing economic growth would yield revenues to pay for the higher deficits. And the removal of regulatory red tape would liberate entrepreneurial innovation.

The recipe failed on all counts. Public deficits didn't shrink; they grew. Individual savings fell. Total national savings -- depleted by public deficits -- fell even further. So did private and public investment. The deregulation only engendered speculation and a mountain of bad debt.

Not surprisingly, growth stalled. The economy is so shaky today that it has grown dependent on chronic deficits of a scale unimaginable before 1981. Even with these deficits it cannot manage a robust recovery.

Adding to the problems is an immense overhang of empty offices and condos -- fruits of the speculative '80s. As the value of these properties drops, investors lose money, banks keep incurring losses and the financial wealth of the public erodes.

In this climate, increasing the money supply or lowering interest rates, or even encouraging banks to lend more by tinkering with capital requirements, fails to have tonic effect. The dilemma is not new. In the 1930s, economists recognized that attempting to cure this kind of chronic slump with cheap money was like "pushing on a string."

One new element also blunts the monetary weapon. Some 40 million older Americans today depend heavily on interest and dividend income. Every time the Fed reduces interest rates, Grandma's new Treasury bonds or certificates of deposit pay less interest. So, by cutting interest rates with one hand, the Fed cuts purchasing power with the other.

The present situation is a milder version of the '30s. Purchasing power has not collapsed entirely, thanks to Social Security and deficit spending. But it has eroded. As has the power of banks to absorb normal losses. The supply-side turkey has finally come home to roost.

If fiscal, monetary, and regulatory policy are all impotent to engender recovery, the economic debate of 1992 will come down to two choices:

* The Bush administration will propose another round of supply-side capital-gains cuts for private investors. If the Democrats don't laugh this proposal right out of public debate, they deserve to lose again.

* The alternative is a recovery fueled by public investment and financed by selective tax increases -- an approach you are likely to hear from the Democrats. In a structurally depressed economy, a tax cut given to millionaires may not be invested. But if you raise taxes on the same millionaires and use the proceeds to rebuild roads, schools, rail lines and the other ignored needs of the '80s, all of the money is put to productive use.

The last two Democratic nominees were the consensus candidates of the party establishment. Both failed to offer any economic vision beyond austerity (Mondale) or good management (Dukakis). In 1992, with the pundits already having ceded the election to Bush, and the Democratic "heavyweights" sitting out the race, an outsider Democrat with little to lose may finally treat the voters to a real debate about the economy.